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Monday's Top Upgrades (and Downgrades)

This series, brought to you by Yahoo! Finance, looks at which upgrades and downgrades make sense, and which ones investors should act on. Today, our headlines feature a pair of bright new kicks from Citigroup, which has announced buy ratings on both Skechers USA(NYSE:SKX) and Deckers Outdoor(NYSE:DECK). Before we get to this good news, though, let's take a quick look at why...

Argus Research just downgraded Kimberly-ClarkAs markets turn up to begin the new week, Kimberly-Clark(NYSE:KMB) stock is notable for sitting out today's rally. For this sad fact, you can thank the analysts at Argus Research, who chose to downgrade Kimberly-Clark stock today.

Citing rising commodity costs and currency headwinds -- but most important, a too-high stock price, Argus cut its rating on K-C stock to hold. Adding injury to insult, the analyst also withdrew its price target from the stock entirely. No longer does Argus think K-C shares will rise to $120 by year-end. Rather, Argus doesn't know what the stock might be worth. It's a good bet, however, that the shares are worth a whole lot less than the $110 per share that they currently cost.

Here's why: Priced at 20 times earnings (or more than 22 times earnings if you count the company's $5.7 billion in net debt against it), Kimberly-Clark shares sell for a whole lot more than their projected earnings growth rate of just 7% would appear to justify. That's true even given the company's generous 3% dividend yield. Free cash flow at the paper-products maker, while substantial, lags reported net income by a not-insignificant margin. The $1.9 billion in cash profits that K-C generated over the past year backs up only about 90% of reported earnings.

Long story short, while it's a fine company in many respects, Kimberly-Clark shares quite simply cost more than they appear to be worth. Argus is right to downgrade the stock.

Skechers off to the racesTurning now to happier news, investors in the shoe sector -- yes, there appears to be such an ultra-specific thing -- are leaping out of the gate Monday, and racing ahead in response to a pair of new buy ratings from investment megabanker Citigroup.

Let's take Skechers first. Describing Skechers as "a high-growth name trading at near-mkt level valuation," Citi says Skechers shares are poised to run up to $49 within a year, generating a nice 15% gain from current prices.

Personally, I'm not convinced by the analyst's argument, however. While Skecher's valuation of 16 times next year's projected earnings may suggest it's selling for a "market multiple" as the analyst argues, a more conservative view of the stock would focus on the fact that Skechers shares currently cost 27 times trailing -- and thus inherently more reliable -- earnings. Relative to that valuation, I can't say as the 15% long-term growth rate that most analysts assign to the stock looks particularly enticing.

True, in the stock's defense, Skecher's does boast strong free cash flow -- actually a bit better than it reports as GAAP profits, at $80 million for the past 12 months. And Citi's argument that Skecher's is growing strongly through use of own-brand stores selling directly to consumers, and through sales over the Internet as well, helping it to grab additional market share, improve profit margins, and grow earnings, certainly has merit. Still, if all of this is only going to add up to the 15% growth that we've been led to expect, well, that's a respectable figure to be sure. I'm just not convinced it's worth paying 27 times earnings for.

Building a better buy thesis for Deckers Could prospects for Citi's other shoes pick be better? Maybe, just maybe, yes. At the same time as Citi picked Skechers to outperform the market, it also gave its seal of approval to Uggs-maker Deckers Outdoor -- and this one has real promise.

Citi sees Deckers growing sales at about 10% annually over the next five years, and earnings per share going up 14% annually at the same time. These growth rates, argues the analyst, are worth about 14.6 times next year's projected earnings.

Granted: At $80 a share, Deckers shares alreadycost more than 14.6 times the forward earnings estimates of most analysts. So to reach Citi's new price target of $94 a share, Deckers must both earn more than the $5.47 per share that everyone else thinks the company will earn next year, and also continue growing earnings several percentage points faster than the 11% consensus heard elsewhere on Wall Street.

These would seem high hurdles for the boot maker to leap, but for one thing: Deckers currently generates superb levels of positive free cash flow -- $209 million over the past 12 months, or about 47% more than shows up on the company's income statement as GAAP earnings. This number suggests to me that Deckers is more profitable than it looks, and could very well earn more than the other analysts are expecting -- potentially proving Citi right on its buy recommendation.

Mind you -- at a valuation today of about 13 times trailing free cash flow, and with no dividend payments to its shareholders, I still see Deckers as modestly overvalued for the consensus 11% growth rate. But if Citi turns out to be right about profits at Deckers outgrowing the consensus, at, say, 15%, then the stock could actually be cheaper than it looks. It's not a strong buy argument, certainly, but is it a potential reason to buy the stock on broader weakness in the markets? Why yes, I suspect it just might be that.

Motley Fool contributor Rich Smith has no position in any stocks mentioned, and doesn't always agree with his fellow Fools. Case in point: The Motley Fool recommends Kimberly-Clark.

Author

I like things that go "boom." Sonic or otherwise, that means I tend to gravitate towards defense and aerospace stocks. But to tell the truth, over the course of a dozen years writing for The Motley Fool, I have covered -- and continue to cover -- everything from retailers to consumer goods stocks, and from tech to banks to insurers as well. Follow me on Twitter or Facebook for the most important developments in defense & aerospace news, and other great stories besides.